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07 April 2014 Repo desks up in arms about NSFR

The cost of some repo transactions would leap 850 per cent under a draft version of the NSFR, banks claim. One regulator admitted last week there could be unintended harm to the market and implied the rules could change.

Estimates of the impact are rough, but industry sources say the problem – which arises because banks would be required to hold term funding equal to half the size of some transactions – was only spotted in early March. Since then, one industry working group is said to have held more than 20 calls on the topic, while another is thought to be working on a full impact study. The NSFR proposal is a concern as it introduces an asymmetry between repo and reverse repo with non-bank financials.

The early analysis has been credible enough to get the attention of regulators. Speaking at a Risk conference in London last week, the chair of the Basel Committee on Banking Supervision's liquidity working group, Sylvie Matherat, alluded to the problems during a roundtable discussion.

Some industry sources dispute the idea that the impact would be unintended. They claim some bank supervisors want to shrink the repo market, and point to a string of other new rules in which repo was initially treated harshly. It was the simultaneous publication of the final, more favourable, text for one of these – the leverage ratio – that initially distracted the industry from the problems in the NSFR, says one lobbyist.

In a speech on the topic of shadow banking last November, Federal Reserve Board governor Daniel Tarrullo outlined ways of making securities financing more expensive and, he argued, reducing the systemic risks posed by the market. "With the NSFR still under discussion, and with the Basel Committee in the process of reconsidering the standardised banking book risk weights and capital regulations associated with traded assets, there are opportunities to pursue these options", he said.

The NSFR seeks to make banks more resistant to liquidity risk by pushing them away from short-term wholesale funding. It is calculated by dividing the bank's available stable funding (ASF) by its required stable funding (RSF), with a minimum of 100 per cent. The ASF and RSF totals are determined by applying a regulator-set multiplier to bank assets and liabilities.

The problem is that the January proposals introduce an asymmetrical treatment for repos when conducted with non-bank financial entities such as money market funds and asset managers, which are big users of repo.

The draft rules state that if a bank acts as the security lender in a repo with a maturity of less than six months, it would attract a 50 per cent RSF. This is matched by a 50 per cent ASF if the counterparty is a non-financial corporate, meaning there is no net funding need, but the ASF drops to 0 per cent for trades with non-bank financials – for every $100 dollars lent out, $50 of term funding would be needed.

Liquidity in the repo market could also take a hit. The European bank's securities financing specialist says the impact of the NSFR, combined with the final version of the leverage ratio, could lead banks to retreat from securities lending. If banks reduced their reverse repo business by 20 per cent, she says, it would remove $1 trillion of financing capacity from the market. In turn, this could threaten the ability of pension funds to repo out their assets to meet cash variation margin calls on cleared derivatives portfolios – a scenario that is already causing concern.

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